Archive for September, 2013

Ray Dalio, founder of the remarkably successful Bridgewater Associates, has released a 30 minute video explaining his vision of “How the Economic Machine Works.” Well worth watching, particularly his description of a beautiful deleveraging.

Today I had the chance to testify before the Joint Economic Committee about a perennial challenge, the looming debt limit. Here are my opening remarks. You can find my full testimony here.

I’d like to make six points about the debt limit today.

First, Congress must increase the debt limit.

Failure to do so will result in severe economic harm. Treasury would have to delay billions, then tens of billions, then hundreds of billions of dollars of payments. Through no fault of their own, federal employees, contractors, program beneficiaries, and state and local governments would find themselves suddenly short of expected cash, creating a ripple effect through the economy. A prolonged delay would be a powerful “anti-stimulus” that could easily push our economy back into recession.

In addition, there’s a risk that we might default on the federal debt. I expect that Treasury will do everything it can to make debt-service payments on time, but there is a risk that it won’t succeed. Indeed, we have precedent for this. In 1979, Treasury accidentally defaulted on a small sliver of debt in the wake of a debt limit showdown. That default was narrow in scope, but financial markets reacted badly, and interest rates spiked. If a debt limit impasse forced Treasury to default today, the results would be more severe. Interest rates would spike, credit would tighten, financial institutions would scramble for cash, and savers might desert money market funds. Anyone who remembers the financial crisis should shudder at the prospect of reliving such disruptions.

Second, Treasury doesn’t have any “super-extraordinary” measures if the debt limit isn’t raised in time.

Pundits have suggested that Treasury might sidestep the debt limit by invoking the 14th Amendment, minting extremely large platinum coins, or selling gold and other federal assets. But Administration officials have said that none of those strategies would actually work.

Third, debt limit brinksmanship is costly, even if Congress raises the limit at the last minute.

As we saw in 2011, brinksmanship increases interest rates and federal borrowing costs. The Bipartisan Policy Center—building on work by the Government Accountability Office—estimates that crisis will cost taxpayers almost $19 billion in extra interest costs.

Brinksmanship also increases uncertainty, reduces confidence, and thus undermines the economy. In 2011, for example, consumer confidence and the stock market both plummeted, while measures of financial risk skyrocketed.

Finally, brinksmanship weakens America’s global image. The United States is the only major nation whose leaders talk openly about self-inflicted default. At the risk of sounding like Vladimir Putin, such exceptionalism is not healthy.

Deficits have fallen sharply in the past few years. But current budget policies would still create an unsustainable trajectory of debt in coming decades. Congress should address that problem. But the near-term fiscal priorities are funding the government and increasing the debt limit.

Finally, Congress should rethink the debt limit and the entire budget process.

Borrowing decisions cannot be made in a vacuum, separate from other fiscal choices. America borrows today because this and previous Congresses chose to spend more than we take in, sometimes with good reason, sometimes not. If Congress is concerned about debt, it needs to act when it makes those spending and revenue decisions, not months or years later when financial obligations are already in place. When the dust settles on our immediate challenges, Congress should re-examine the entire budget process, seeking ways to make it more effective and less susceptible to dangerous, after-the-fact brinksmanship.

If you click over to Mt. Gox, the most famous bitcoin exchange, one unit of the crypto-currency will set you back $145. But at Bitstamp you would pay only $129. (At time of writing; prices can change quickly.)

Mt. Gox traders are thus paying a 12% premium for their bitcoins.

That spread seems to violate a fundamental economic law. When transaction costs are low, identical items should trade at nearly identical prices. Otherwise, arbitrageurs would step in to buy cheap and sell dear until the price gap narrows.

But that isn’t happening.

The “law of one price” used to hold. Last fall and winter bitcoin prices at the two big exchanges typically differed by less than 2 percent, a reasonable range given exchange fees and the cost of money transfers (click here if you don’t see the chart or want it bigger):

In April, however, the bitcoin market went haywire. After spiking to $266 on Mt. Gox, bitcoin prices cratered, falling as low as $54 just two days later. That volatility created large, but temporary spreads between prices on different exchanges (and made it difficult to measure spreads accurately).

When conditions calmed, spreads returned to normal. And then Mt. Gox’s troubles began.

On May 14 the U.S. government accused the exchange of operating an illegal money service business. The government seized $5 million that Mt. Gox held at Dwolla (an online payment processor) and Wells Fargo.

Fearing for their money, Mt. Gox customers converted their at-risk dollars into easy-to-withdraw bitcoins, and the Mt. Gox-Bitstamp spread spiked to 5%.

Spreads briefly normalized until Mt. Gox announced that it was suspending U.S. dollar withdrawals. Mt. Gox had become a Roach Motel (or, if you prefer, a Hotel California) for U.S. dollars. Traders could check their dollars in, but they couldn’t check them out.

Customers responded as you would expect. The spread spiked to 6%, as Mt. Gox traders again converted dollars into bitcoins. The spread briefly narrowed after Mt. Gox’s July 4 announcement of resumed dollar withdrawals. But spreads then spiked to record levels once Mt. Gox customers started reporting that withdrawals remained slow or nonexistent.

Mt. Gox prices are higher than on Bitstamp today because customers apparently can’t get their dollars out of Mt. Gox. So they pay extra for bitcoins. For those customers, a Mt. Gox bitcoin is different from one anywhere else. So the Mt. Gox price isn’t a clean measure of a bitcoin’s value. Instead, it measures the value of a bitcoin plus the desperation of Mt. Gox’s customers.

But that still leaves a puzzle. It makes sense that customers will pay a premium to get their money out. But who is willing to take the other side of the trade, selling bitcoins in return for “Mt. Gox dollars”?

As best as I can tell, those traders have stayed silent on the bitcoin chat boards. Perhaps they are newcomers who think they’ve found an arbitrage opportunity and don’t realize their dollars will be hard to withdraw. Or perhaps they believe that Mt. Gox will get its act together. (A more sinister take, raised on the boards, is that some preferred traders do have the ability to withdraw.) Whatever the case, they stand to make a tidy profit if they can get their dollars out, and sorely disappointed if they can’t.

Sources: For a quick explanation of bitcoin, try this introduction. For price data from numerous exchanges, visit bitcoin charts. My chart uses a 7-day moving average of spreads to smooth the volatility. The measured spread has at times been much higher, e.g., 40%+ on April 10, but that passed quickly.